China Drags Down Starbucks’ Comps Growth In Q3

+9.86%
Upside
91.61
Market
101
Trefis
SBUX: Starbucks logo
SBUX
Starbucks

Starbucks (NASDAQ: SBUX) had a mixed third quarter (three months ended June 2018), wherein it beat consensus expectations on revenue and earnings, but had a poor showing in China, its fastest growing market in recent times. The revenue growth was driven by the addition of new restaurants, particularly in China, and this factor, together with a lowering of the corporate tax rate and share buybacks, resulted in a rise in the earnings. The company reduced its full year EPS guidance to $2.40 to $2.42 vs. $2.48 to $2.53 earlier, much lower than our expectation of $2.52. This downgrade is a result of the $0.03 impact of anti-bias training for U.S. partners, as well as the sales for the year being near the lower end of its 3% to 5% growth guidance.

We have a $64 price estimate for Starbucks, which is significantly higher than the current market price. We are in the process of updating our model, based on the new guidance provided by the company. The charts have been made using our new, interactive platform. You can click here for our interactive dashboard on Starbucks’ second quarter performance to modify different drivers, and see their impact on the EPS and price estimate for Starbucks.

Relevant Articles
  1. Down 7% Since 2023, Can Starbucks’ Stock Reverse This Trend Post Q1 Results?
  2. Down 26% From Its Pre-Inflation Shock High, What Is Next For Starbucks Stock?
  3. After 6% Drop This Year, Pricing Growth To Bolster Starbucks’ Q4
  4. Can Starbucks Stock Return To Pre-Inflation Shock Highs?
  5. Starbucks’ Stock To See Little Movement Past Q3?
  6. Starbucks Stock To Likely Trade Lower Post Q2

Key Factors That May Impact Future Performance

1. Growth in China: Although China was the fastest growing market for Starbucks, the growth was driven by the increase in store count. But this factor also caused cannibalization, resulting in a 2% decline in the comparable sales from the region. Another factor blamed for the poor performance is a sharp reduction in third-party orders, with which the company had no formal agreement, as a result of possible government measures. As a response to this, former CEO Howard Schulz hinted at a possible partnership with Alibaba to boost the company’s digital distribution in the country.

China continues to remain a long-term growth driver for the company, as its GDP, projected to exceed $15 trillion by 2021 from $11 trillion in 2014, is expected to fuel a massive increase in its middle class. Moreover, the per capita coffee consumption in China is about one-half of one cup per person per year compared to approximately 300 cups per person per year in the U.S. While consumption levels in China may never be able to match those in the U.S., even attaining a small fraction of it will benefit the company immensely. Starbucks’ partnership with Alipay and WeChat in China and its recent East China acquisition are likely to aid the company in taking advantage of the growing middle class in the country – which is its major customer base. The company expects the impact of the East China business to be neutral or slightly accretive in 2018 and expects to see a more positive impact from this transaction in 2019. The company is also piloting delivery in Shanghai and Beijing this fall, with an intention to expand further in FY 2019. Moreover, despite the hiccup this quarter, SBUX remains on track to add 600 net new stores per year and to achieve its goal of 6,000 stores in 230 cities across Mainland China by the end of fiscal 2022.

2. Innovation in Food and Beverage: As consumer trends evolve, SBUX intends to stay ahead of the market with new and innovative products. Mercato fresh food menu was launched in Seattle and Chicago last year, and continues to perform well. Keeping this in mind, the company is planning to deploy Mercato in nearly 1,800 stores across six markets by fiscal year end. The company sees substantial accretive growth from Draft, Refreshers, Tea, and Cold Brew platforms, and noted that consumer demand for cold beverages has grown from 37% of sales five years ago to over 50% of sales today. There’s also strong demand for customization, including Blonde Espresso as an alternative to its bolder signature roasts, and the inclusion of plant-based milk and cold foam for its cold coffee and tea beverages.

3. Change in Tax Rate: The changes in the U.S. tax laws are likely to impact Starbucks positively. The company expects the effective tax rate to be 7 points below its earlier guidance, at 26% for FY 2018, leading to a slightly higher EPS.

4. Margin Contraction: Given the poor performance in the first quarter, Starbucks is removing over 200 SKUs from its U.S. retail stores, representing over 30% of total lobbied items. While this simplification effort increases the focus of the company and reduces operational complexity in its stores, it will pressure the margins given the high write-offs associated with these products. Moreover, the consolidation of the East China business is expected to have a negative impact on the operating margins. Another factor that will pressure the margins is the digital investments the company is undertaking in the Americas. Given these factors, SBUX projects a moderate operating margin decrease for the year. On the other hand, sliding valuations of the Brazilian Real and the Vietnamese Dong (Brazil and Vietnam are the two largest coffee producing nations in the world), should result in depressed coffee prices, which may be particularly beneficial for a coffee giant like Starbucks.

5. Share Buybacks: Last November, SBUX committed to returning $15 billion to shareholders in the form of buybacks and dividends through fiscal 2020. The company has now expanded that to $25 billion, with $5 billion already returned to shareholders in the first three quarters of FY 2018.

6. Deal With Nestle: Starbucks and Nestle announced plans for a $7.2 billion license deal that would allow the latter to market, sell, and distribute the coffee giant’s brands in Consumer Packaged Goods (CPG) and Foodservice. This global coffee alliance, which brings together the world’s leading coffee brand and retailer, and the biggest food and beverage company globally, gives Nestle a stronger footing in its fight against JAB Holdings, the world’s second largest player in the coffee space. For Starbucks, on the other hand, this deal paves way for expansion into markets where the company has no CPG presence. Starbucks will also be supplying the coffee to both the Nespresso and Dulce Gusto machine platforms, opening its access to the addressable, single-serve coffee market. While the deal will hamper revenue and EPS growth for Starbucks in the short term (expected to have a negative impact of two to three points in FY 2019), it should become accretive to the EPS in three years or earlier.

7. Focus On Drive-Thrus: SBUX intends to open a majority of its new U.S. restaurants in middle America and the south, with over 80% of stores built in the next few years expected to be drive-thrus. The company states that their research has indicated significant opportunities for store expansion in higher growth, lower cost markets, particularly when considering rising wages and occupancy costs. In the U.S., the company is also focusing on its digital initiatives, since it now has 15.1 million active Starbucks Rewards members, up 14% y-o-y. SBUX has reported spend per member growth in the mid-single digits range, with Mobile Order and Pay representing 13% of transactions.

See Our Complete Analysis For Starbucks

 

What’s behind Trefis? See How It’s Powering New Collaboration and What-Ifs

For CFOs and Finance Teams | Product, R&D, and Marketing Teams

More Trefis Research

Like our charts? Explore example interactive dashboards and create your own.